Thursday, February 24, 2011

In a thought-provoking op-ed, Michael Levi of the Council on Foreign Relations has provided a very timely reminder of the role that the strategic petroleum reserves of the US and other nations would play if the turmoil in North Africa and the Middle East spawned another oil crisis. Neither additional drilling nor an accelerated effort on renewable energy would make any near-term difference if oil exports from the Middle East were disrupted. Both strategies are important for our future needs, but the only two tools we have for dealing with an immediate oil crisis are the Strategic Petroleum Reserve (SPR) and old-fashioned conservation. Unfortunately, we've wasted the last couple of years of relative oil-market stability that could have been spent bringing the SPR into the 21st century.

The US government currently has 726 million barrels of oil stored in underground caverns around the Gulf Coast, for use in emergencies. At that level, the SPR is essentially full. The stored oil notionally equates to around 80 days of supply at our current rate of net crude oil imports, though in practice it would provide 165 days of drawdown at the SPR's maximum pumping rate of 4.4 million barrels per day. That is in addition to commercial supplies of crude oil and gasoline and other petroleum products, which currently stand at the equivalent of 24 and 28 days, respectively. However, commercial stocks aren't much of a backstop, because the difference between current levels and those at which the system would start to run out in places amounts to less than a week of normal consumption.

We needn't worry about relying on the SPR if exports from Libya dry up. As I noted in Tuesday's posting, OPEC has more than enough spare capacity to make up such a shortfall, although it's of different quality and might result in some tightness in global diesel markets. But if the current unrest spread and threatened exports from the big producers on the Arabian peninsula, the only thing standing between consumers and much higher oil and product prices would be the SPR and its counterparts in other consuming countries. With combined inventories of at least 1.6 billion barrels, these reserves are in good shape to respond to a drop in exports of a few million barrels per day for several months, though not necessarily a sustained curtailment or a much larger one. And any use of these reserves should be coordinated among consuming nations, as Mr. Levi pointed out in his op-ed.

This all sounds good in principle, and I have no doubt that even the announcement of the intent of the US and others to draw promptly on these stocks if the situation deteriorates further would do a lot to calm markets. At the same time, it's important to understand how much the world has changed since the SPR was first planned and implemented, as a result of the first oil crisis in 1973-74. As I commented three years ago:

"In addition to importing much larger volumes of crude oil, our refinery capacity hasn't kept pace with demand, resulting in steadily growing imports of gasoline and gasoline blending components. And in the interim, oil production in Alaska and California has fallen into deep decline, requiring crude and product imports into a maxed-out West Coast refining system.

So instead of a strategic reserve designed to provide a back-up supply of crude oil to Gulf Coast and Mid-continent refineries serving the entire US east of the Rockies, our needs have expanded to encompass oil and refined product imports on all three coasts. These altered circumstances suggest the need for a more diverse and dispersed SPR, perhaps modeled along the lines of the federal Northeast Heating Oil Reserve. Nor do I believe that the only practical model of such a reserve entails government ownership and custody of the hydrocarbons in question. Other countries achieve the same end with a requirement for oil companies to maintain mandatory minimum inventory levels at no direct cost to taxpayers."

That's as relevant today as when I wrote it, with the addition that the SPR's potential effectiveness has been further affected by the buildup of crude in the Mid-continent as a result of increased output from Canadian oil sands projects and the rapidly growing output of the Bakken Shale. This is one of the main reasons why West Texas Intermediate is trading at roughly $100 this morning, while UK Brent crude, which is normally within $2 of WTI, has spiked over $118. I also can't resist pointing out that the market is hitting us in the face with a two-by-four concerning the potential energy security value of US natural gas, which is still trading at an oil-equivalent price under $27 per barrel for all of 2011, despite the events in the Middle East.

I don't blame the last two administrations or Congress for not having made SPR reform a higher priority in the last three years. They had a few other things on their plate. However, even if the current crisis in Libya and the Middle East resolves itself quickly and without further impact on world oil supplies, it provides another unwelcome reminder that we live in a world in which the President and other world leaders might need to call on our strategic oil inventories on very short notice to prevent a catastrophic breakdown of the economy. In that context, redesigning our 1970s-vintage SPR to be more effective in a greatly altered landscape ought to rise to a similar priority as addressing other urgent concerns such as the deficit.

Tuesday, February 22, 2011

The unrest that began in Tunisia and Egypt has now destabilized a country that exports important quantities of petroleum, and the oil market is reacting in earnest. With Libya in violent turmoil, UK Brent crude traded above $108 per barrel today, and even West Texas Intermediate (WTI), which has been massively discounted due to excessive inventory at its Cushing, OK delivery point, hit $98 in early trading before falling back to the mid-$90s. Unless events in Libya resolve quickly and positively, oil's price moves will shortly translate into higher gasoline prices. As I considered these events over breakfast, it also struck me that GM and Nissan could turn out to be very lucky indeed in launching their electric vehicles now, instead of a year or two ago when gas prices were lower and less volatile.

The media commentary I've seen so far concerning Libya's oil production has missed some key details that explain why a disruption of exports that in theory can be covered by OPEC's ample spare capacity--currently at a multiple of Libya's output--could be disproportionately large. Instead of focusing on Libya having Africa's largest oil reserves--a fact that is important for the long run but essentially irrelevant in the current situation--what matters is production and exports, and especially the location and quality of the latter. Libya produces around 1.7 million bbl/day of crude oil and exports much of that, due to its small domestic market. As oil companies evacuate personnel, that output will drop, and exports from Libya's ports are at risk of disruption by the chaos unfolding there. The majority of those exports stay in the Mediterranean, where they are key inputs for Italian, French and Spanish refiners. Very little of it comes to the US, for which Libyan oil made up less than 1% of our imports in 2009. So any effect on US markets will be indirect, but no less dramatic for that.

On the surface, OPEC is more than capable of making up for the loss of a bit over 1 million bbl/day from the market, if it wished. However, most of the cartel's roughly 5 million bbl/day spare capacity is on the Arabian peninsula--near another focus of instability in Bahrain, which is no longer an oil exporter. Nor is most of OPEC's remaining capacity of a quality comparable to the typically light, sweet crude types that constitute most of Libya's output. These crudes are well-suited for making the diesel favored in Europe, and it would be difficult for many European refiners to switch on short notice to a diet richer in Saudi grades that are higher in sulfur.

Various analysts have noted that US gas prices were already reflecting higher world oil prices, rather than the lagging WTI indicator. With April gasoline futures trading above $2.75/gal. on the NYMEX this morning, that would yield an effective average US retail unleaded regular price of around $3.45/gal, after factoring in excise and sales taxes and typical dealer margin. That's well above the $3.18/gal. average that the Lundberg Survey reported for last week. It would also be the highest average at the pump since October 2008, when prices were unraveling from their $4-plus peak of that summer.

It's too soon to predict an imminent return to those heights, although no one can gauge what will happen next in Libya, where it's not even clear who's in charge at the moment. (It does seem safe to predict that the US will not lead a NATO invasion of Libya, as Fidel Castro has apparently warned.) Still, it is worth thinking about how consumers might react if the current chaos persisted. The last time gas prices rose sharply, we saw significant drops in both US vehicle miles traveled and gasoline consumption. We also observed a noticeable increase in the sales of hybrid cars, which have lagged recently. There were no mass-market electric vehicles available at the time, but it doesn't require a leap of faith to envision a healthy boost in EV sales from their low initial levels, too. That would be good for both GM and Nissan, which have invested enormous sums--and their corporate reputations--bringing their Volt and Leaf models to market. It might not be so positive for sales of clean diesels, despite their high efficiency, if constraints on Libyan oil tighten European diesel supplies and drive up world diesel prices.

Events in North Africa and the Middle East will determine how high oil and gasoline prices rise in the weeks ahead. If Libya's dictator departs as readily as President Mubarak did, things could settle down quickly, unless the unrest spreads to another major oil producer. It's still too early to call this a new oil crisis, but it's not too soon to consider our options if it proved to be one. Although that would be a very unwelcome shock to an economy just regaining some momentum, we have many more options than in 1979, when the Iranian Revolution sent oil prices to levels that it took nearly three decades to exceed, in real terms.

Friday, February 18, 2011

The editors of the Washington Post have expressed serious reservations concerning the administration's plans for investing up to $53 billion in new high-speed rail systems, with the goal of linking 80% of the US population by a new fast rail network. If the facts they cite concerning the ongoing subsidies such systems require in other countries are correct--including countries with more suitable geography for high-speed trains--then attempting to follow their lead here could amount to buying a gigantic money pit. While I certainly see the benefits of high-speed rail as part of an upgraded US transportation infrastructure, I'd like to see the architects of the current proposals provide some hard numbers on how high speed rail compares to our alternatives.

This is a hard subject for me to approach objectively, because I love trains. Access to convenient and reliable rail service was one of the great joys of the two years I spent living in the UK and traveling on the Continent of Europe. I now routinely take Amtrak's Acela service in preference to flying between D.C. and New York, particularly in light of the hassle that air travel has become, especially for short distances. Yet as much as the thought of sleek 200 mile-per-hour trains running on a network of smooth high speed tracks and connecting most major US cities appeals to me as a train fan and futurist, I'm also acutely aware of the cost and risk of such endeavors. For example, despite carrying more than 9 million passengers a year the channel tunnel system connecting London and Paris, which impressed me greatly when I rode it in the late 1990s, declared bankruptcy in 2006. It is now just barely profitable, earning a negligible (negative?) return on its original investment. The UK recently sold off its portion of the line to pay down government debt.

The World Bank report on high-speed rail cited by the Post was generally positive concerning developments in China and elsewhere, though also full of red flags: "The demographic and economic conditions that can support the financial or economic viability of high-speed rail are limited." "The established lines with greatest demand are in East Asia..." "Nevertheless, high-speed rail projects have rarely met the full ridership forecasts asserted by their promoters and in some cases have fallen far short." "Governments contemplating the benefits of a new high-speed railway... should also contemplate the near-certainty of copious and continuing support for the debt." It also explains why high-speed rail is attractive in China, attributing it to, "The combination of supportive features that exist on the eastern plains of China including very high population density, rapidly growing disposable incomes, and the prevalence of many large cities in reasonable proximity to one another..." To that I might add the relative lack of competition from underdeveloped road and air infrastructure. Yet even in China its high cost is drawing criticism.

I'm also not clear on the non-transportation economic benefits for the US, particularly if the core train technology for systems like California's current high-speed rail project is likely to come from Japan, France or Germany. And while the California project cites greenhouse gas savings of 6 million tons per year, that doesn't sound quite so impressive in the context of its $10 billion initial cost. And the total is sure to go much higher, considering that the cost of the first leg, the so-called "train to nowhere" in the Central Valley, is over $4 billion and includes neither rolling stock nor power supply.

So here are some basic questions I'd like to see answered, in lieu of the largely aspirational rhetoric we've heard so far, before I'd be pleased to see my tax dollars spent on this initiative:

What is the projected return on capital and net present value of the investment?

What is the effective cost per barrel of achieving the oil and other energy savings projected for the first 20 years of operation?

What is the implied cost per ton of the resulting emissions reductions, assuming that the system is powered by the average US grid mix, and how does that compare to other ways to reduce emissions?

How do these results compare to the same metrics for other transportation investments that could be made with these funds, including modernization of US airports and air traffic control systems, key highway segment upgrades, and electric vehicle recharging infrastructure?

Wednesday, February 16, 2011

This week the administration issued its third budget since taking office in January 2009. In a year otherwise focused on belt-tightening, the proposal includes a 12% increase for the Department of Energy, focused on additional R&D for renewables and nuclear power. The increase would be offset by cuts in fossil energy programs and the elimination elsewhere in the budget of various tax deductions and tax credits--"tax expenditures" in Beltway parlance--that benefit the US oil and gas industry. Also new for this year are proposed additional fees on the industry to cover the increased cost of issuing drilling permits in the aftermath of the Deepwater Horizon accident, along with another provision to raise the cost of holding inactive oil and gas leases. Aside from the politics involved, this exercise reminds me of the periodic waves of cost-cutting I experienced at Texaco, Inc. in the 1980s and '90s. Unfortunately, the government hasn't yet learned the vital lesson that my former company and many in other industries finally figured out after years of experience: Reducing expenses only helps your bottom line when the items you are cutting contribute less in revenue than they cost.

Start with the oil and gas subsidies, which I've discussed previously. The newly submitted budget estimates these at approximately $4 billion per year. As we heard the President say in his latest State of the Union address, "I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to the oil companies. (Applause.) I don't know if--I don't know if you've noticed, but they're doing just fine on their own. (Laughter.) So instead of subsidizing yesterday's energy, let's invest in tomorrow's." It's a guaranteed applause line, as the White House's own text indicates, despite including potentially serious errors of fact.

Now, one could argue in the abstract whether a tax credit or deduction constitutes a gift of "taxpayer money" (i.e., the government's) or an opportunity for the taxpayer in question to remit less of his own money to the government. I know how I feel about that when it comes to filing my form 1040. One might even arrive at different answers in different situations. As a practical matter, however, what counts in the current context is not whose money this is in the first place, but whether taking more of it leaves either the federal government or the US economy better off. Even from the perspective of tax revenue, a recent study found that after an initial increase, the long-term impact of higher taxes on the oil & gas industry resulted in reduced government revenue. Higher taxes on US oil & gas production will translate into less of both--and so less to tax--while also yielding more future imports and higher trade deficits, along with reduced energy security.

The President's remarks also suggested incorrectly that oil and gas are yesterday's energy, and not also today's and tomorrow's. In 2009 oil and gas accounted for 62% of our energy consumption, and the US Department of Energy expects them to continue to supply as much as 57% of our needs in 2035, after subtracting the contribution of liquid biofuels. Treating these key energy sources as undesirable could have serious consequences for our energy and economic security in the years ahead. Nor would it assist our efforts to reduce greenhouse gas emissions. Natural gas can contribute significantly to reducing the emissions from the power sector, which accounts for 40% of US CO2 emissions, and the main opportunities for reducing emissions from transportation, where most of our oil use takes place, are on the user side--conservation and more efficient cars, trucks and planes--and not on the extraction, refining and distribution side of the industry.

If the administration couldn't get these tax changes enacted in the previous Congress, they stand even less chance this term. However, that might not be the case for the additional "user fees" and lease fees, since they are new this year. The former are related to the redesign of the oversight agency for offshore drilling and were recommended by the Presidential commission investigating the accident. As I noted when their report came out, we already have a mechanism for recouping the expenses that the Bureau of Ocean Energy, Management, Regulation and Enforcement (formerly the Minerals Management Service) incurs in the course of reviewing leases and drilling permits and monitoring offshore activity. That mechanism is the lease bids and royalties that brought in $8 billion from onshore and offshore oil and gas in fiscal 2010. In a good year these sums could cover the entire Interior Dept. budget, let alone that of BOEMRE. Adding new fees on top of the existing royalties further reduces the attractiveness of drilling in US waters, on top of the "moratorium/permitorium" --now in its tenth month--for which critics finally received a belated explanation earlier this month. The net result of new fees would be less drilling here and more drilling in places like offshore Brazil.

Then there's the notion of "establishing fees for new non-producing oil and gas leases (both onshore and offshore) to encourage more timely production." This is clearly an outgrowth of the "idle leases" canard that was making the rounds in 2008. However, in light of protracted delays in issuing new permits and the likelihood that fewer permits will be issued in the future than in the past, it seems almost Kafkaesque to penalize companies for not drilling sooner on more of their leases. In truth, companies already pay twice for non-producing leases: once when they pay a bid bonus to acquire the lease, and then every year in the form of a lease rent that is due as long as the lease remains undeveloped. Companies factor this into the bonuses they bid, along with their assessment of the likelihood that a lease contains commercial quantities of oil or gas. Additional fees on non-producing leases seem likely to result in one or more of the following outcomes: lower bonus bids, fewer bids, and an increased focus outside the US. None of that would help either the deficit or energy security.

I'm entirely supportive of the government cutting expenses, including unwarranted subsidies, in order to begin the difficult task of bringing the federal budget closer to balance within the next few years. This seems essential if we're to avoid serious consequences for our credit rating, interest rates, and exchange rate. However, along the lines of what I saw when the oil industry reduced expenses in the aftermath of the big oil price drops of the mid-1980s and 1998-9, it would be counterproductive to do so in a manner that would actually result in lower overall tax receipts, while reducing domestic energy production in the bargain. Ultimately, it makes a lot more sense to target repealing the tax expenditures in question as part of the broader tax reform that seems inevitable if we want to get the deficit under control. That would eliminate specific tax breaks but simultaneously reduce overall corporate tax rates to make US industry more competitive globally, not less. A budget that proposes to double corporate income tax receipts by 2013--to a level higher than their 2007 asset bubble peak--is out of step with the competitiveness agenda that the administration has espoused, aside from its shortcomings in narrowing the long-term deficit.

Monday, February 14, 2011

A summary of annual risk forecasts in a Linked-In group led me to a very interesting presentation on global risks from the World Economic Forum, the body that puts on the annual movers-and-shakers shindig at Davos, Switzerland. Among the risks they highlighted are those associated with what they termed the "water-energy-food nexus". The food vs. fuel concerns I explored in Friday's posting make up just one subset of this much larger and more complex set of interactions. These can be further expanded--and complicated--by incorporating the relationships between this triad and climate change. Although the WEF identified a number of steps that could be taken to address this poorly-appreciated challenge, it requires a leap of faith to imagine we could tackle this issue as systematically as it seems to merit, in light of our track record on other big but comparatively simpler challenges such as energy security and the ongoing deficit and debt problems of the developed world.

The extra complexities resulting from adding water to the already thorny food-fuel relationship are nicely illustrated by a systems chart in the WEF's analysis. It shows food security, water security and energy security linked by a series of sometimes reciprocal inputs, and influenced by other factors such as population and energy growth and environmental pressures, along with two overarching risks of global governance failures and economic disparity. All of this leads toward geopolitical conflict. It's a sobering assessment, even without including the missing arrow flowing back from food security to energy security. Biofuel produced from food crops makes up an increasingly important source of global liquid fuel supplies, so the "food intensity of energy production" deserves inclusion with these other factors, too.

This isn't the first time that I've seen a diagram portraying these interactions. I can't help wondering whether the WEF viewpoint was influenced by some scenario work that I encountered through my involvement with Global Business Network in the 1990s and early 2000s. I was fascinated by Gerald Harris's description of the triangle connecting water, food and energy, which has become much more apparent in the years since I first saw it. Although at the time the traditional energy industry understood its relationship with water pretty well, the water intensity of corn ethanol wasn't yet an issue, because US ethanol production was under 2 billion gallons a year, less than a sixth of its current level. And while some oil and gas wells have been hydraulically fractured for decades, the mass application of this technique to unlocking shale gas resources was still in its early days and hadn't percolated into the public's consciousness. Yet while the use of (and impact on) water in energy has become a much higher profile issue, metrics for comparing the water intensity of energy produced from different sources are still evolving. And we've barely begun to think about how for example water, which requires energy to capture and distribute, is used in producing energy, affecting the availability of water for growing food, some of which is then turned into energy. You can start similarly convoluted chains with food or energy, too.

We've typically looked at issues such as those in the examples above in terms of simple, binary decisions, rather than complex tradeoffs calling for integrated resource planning among all affected parties, at both the regional and local level, and markets that account for as many of the real costs and relevant externalities as possible. Yet without taking anything away from the work of the groups that the WEF mentions are looking at these problems in Indochina, Jordan, and elsewhere, we simply don't have the kind of governance in place to do this globally. If the UN can't come to grips with climate change and nuclear proliferation, then the future of the "water-food-energy nexus" seems far likelier to play out either in isolation or as a series of one-off efforts among highly motivated (desperate?) parties. And with last year's favorite governance body, the G20, heading into what some are calling a "G-Zero" world, it's not clear who else could take up this mantle. In the absence of some improbably comprehensive global approach to managing these interdependencies, it's up to those working in the affected industries to ensure that these factors are at least reflected in the planning and analysis of major projects and investments.

Friday, February 11, 2011

Today's Washington Post includes a noteworthy opinion piece from Tim Searchinger of Princeton University concerning the impact of expanding biofuel production on global food prices and availability. Food vs. fuel competition made headlines in 2007 and 2008 but then subsided during the recession and financial crisis. This year, with global crop yields down and food demand up, and with food-derived biofuel production at record levels, the issue has returned. The relationship between biofuel output and food prices is certainly complex, but it is significant, particularly for those who spend much of their incomes on unprocessed grains and vegetable oils. And both population and biofuels demand will continue to increase from today's levels.

You might recall Mr. Searchinger's name in conjunction with a high-profile scientific paper in 2008 casting doubt on the value of crop-based biofuels in reducing greenhouse gas emissions. "Global land use impact" entered the lexicon of environmental consequences as a result of his and his collaborators' work, and it had a significant influence on the EPA's updated Renewable Fuel Standard (RFS) regulation, even if the agency's final version of the rule softened its application in constraining the least efficient corn ethanol facilities. So you might say that Mr. Searchinger is no great friend of first-generation biofuels in general. However, the issue that he's writing about today, while no less controversial in energy and policy circles, is much more straightforward to understand than the carbon debt of newly cultivated cropland.

As he notes in his op-ed, numerous studies have demonstrated a link between biofuel production and food prices in 2007-8, even in the US, where the basic inputs subject to this kind of price competition constitute a small portion of the retail prices of the processed foods we eat. It affects US food price inflation, but mainly indirectly through routes such as raising the price of livestock feed. Among others, the Congressional Budget Office looked at this issue in 2009. Most of the studies I saw also showed a significant effect on food prices from rising energy prices, another phenomenon that has reappeared in the last year. However one interprets all this, it is inescapable that a bushel of corn turned into ethanol is not available for export to countries that are experiencing a combination of rising demand and disappointing harvests.

If anything, the conclusion of Mr. Searchinger's op-ed downplayed the risks ahead. With output from the nascent cellulosic ethanol industry still minuscule, the EPA will be under tremendous pressure to allow corn ethanol to continue to expand beyond its current 15 billion gallon per year limit under the RFS. That's one reason the industry was pushing so hard to increase the maximum allowable percentage of ethanol in gasoline from 10% to 15%; it needs that headroom to continue expanding output beyond last year's 13 billion gallons. At 20 billion gallons per year--a quantity that I heard one USDA expert suggest several years ago was achievable--ethanol would require the equivalent of 55% of 2009-10's record US corn crop. It's hard to envision that happening without concerns about food vs. fuel rising to a much higher pitch.

Wednesday, February 09, 2011

Having recently taken a hard look at the cost/benefit of the proposed expansion of federal electric vehicle tax credits up to $19 billion, it naturally caught my attention when I heard that the President was proposing to convert the present system of tax credits into point-of-sale rebates for EVs. Legislation has apparently been introduced to put that into effect, along with a significant expansion of federal grants to manufacturers of EV batteries and other components. Aside from my sense that taxpayers have already subsidized that industry sufficiently for its current stage of development, I have distinctly mixed feelings on the EV tax credit conversion, which seems likely to increase the cost of the program, though it would also increase its fairness.

When the Congress originally established this benefit under the TARP bill in October 2008, it opted for the most conservative of the three main ways it could have provided incentives to purchasers of electric vehicles. First, it chose tax credits rather than cash rebates. That at least provides a time value of money benefit to the government, though it opens the door to a certain amount of fraud. Tax credits also ensure that purchasers must be serious about their investment, since they have to pay more of their own money up front and then wait to recover it when they file their next tax return. But Congress raised the bar even higher by choosing to make the EV tax credits non-refundable. That means that not only must you wait to file your taxes to get the benefit, but the credit cannot exceed your annual tax liability in order to take advantage of the full amount. The last time I checked, that implied that a typical EV buyer would need to earn at least $55,000 per year if single, or $75,000 if married filing jointly--after normal deductions and exemptions. That makes buying an EV with the government's assistance a distinctly middle- to upper-middle-class proposition, at least.

The main advantage of turning the tax credit into a rebate is in making it available to more people, and in the process putting more EVs into the hands of less affluent buyers. That works two ways, by expanding the pool of those who would qualify for the incentive, and also by making it easier for buyers to qualify for financing an EV purchase by reducing the amount that had to be financed. I could envision this putting more people in EVs, sooner than under the current system. Of course that's also its chief drawback, from a taxpayer and federal borrowing perspective. The faster the money is spent, the quicker the deficit grows, or the more taxes must go up--or other programs be cut--to pay for it. It also appears that car dealers are less than enthusiastic about becoming the gatekeepers for this benefit.

Having generally supported the earlier "cash for clunkers" rebates, I was initially somewhat receptive to this idea, even if I didn't see similarly unique circumstances to justify it. However, I'd be a lot more enthusiastic if I thought the change were mainly driven by the imperative to improve our energy security--a logic negated by the paltry amount of oil the first few million EVs will save--instead of shoring up a somewhat arbitrary target that was announced in the recent State of the Union address and has attracted a fair amount of skepticism, including from the car industry that is supposed to execute it. In the end I come down on the side of my fellow taxpayers on this one. Let's leave the tax credit as is and allow the early adopters who qualify for the current version to help bring down the cost of EVs, so that more price-sensitive buyers won't need a $7,500 rebate to afford one later.

Monday, February 07, 2011

I just read an intriguing article by the inventor of a scheme for using the energy in off-peak wind power to recycle waste CO2 into hydrocarbon fuels like gasoline or diesel. If it works, it would be a clever way to finesse the energy storage challenge that has hampered wider application of intermittent energy sources such as wind, and it appears to rely on largely proven chemistry and technology. Like so many other novel energy ideas I encounter, it almost sounds too good to be true. In this case determining whether it is or isn't depends less on the technology involved than on an assessment of the markets that the developer's company, Doty Energy, would have to tap for its inputs. In a nutshell, I question whether it's possible to base a new fuels industry on the assumption that off-peak wind power will always remain dirt cheap.

The basic opportunity on which Dr. Doty's "Windfuels" concept seeks to capitalize is that because wind turbines don't necessarily generate power when the grid needs it, and because it's currently expensive to store electricity unless you have a hydropower dam and the right topography handy, much of the off-peak wind power the grid can accept is sold for a song, while some is "curtailed", or rejected by the grid entirely. With a substantial supply of wind power costing just a penny per kilowatt-hour (kWh), it might be possible to convert that excess wind energy into chemicals, effectively storing it in the form of gasoline, diesel or jet fuel.

The process described on the company's website marries three distinct segments, including electrolytic generation of hydrogen--an off-the-shelf item--Fischer-Tropsch synthesis of hydrocarbons--proven in a variety of applications since before World War II--and the conversion of CO2 and hydrogen into synthesis gas using the reverse of the standard water-gas shift reaction that is in wide use in the chemical and refining industry. The company must prove that it can master the latter step and integrate these components successfully into a scheme that is ultimately driven by an intermittent and unreliable energy source, off-peak wind generation. The operational challenges that presents might be surmounted by means of pressurized hydrogen storage, as suggested in the flow diagram provided in a company presentation, but the economic obstacles involved seem less straightforward.

Assuming this process could be made to work effectively and efficiently, its inputs and intermediate steps raise questions about the cost and value of these streams. The biggest probably relates to the long-term availability of cheap off-peak wind power itself. Based on cumulative capacity and output, the average capacity factor of US wind generation in 2009 was around 27%. I don't know how much of that was off-peak, but it was probably less than half. While Doty Energy sees an opportunity to arbitrage between wind power at 1¢/kWh and gasoline that currently wholesales for an energy-equivalent price of 7¢/kWh, developers of electrical energy storage systems see an arbitrage opportunity between cheap off-peak power (from any source) and peak power markets in excess of 20¢/kWh, or occasionally much more. Even if Doty's process, which it claims is 50% efficient overall, worked as well as energy storage technologies such as compressed air energy storage (CAES), it seems likely that the future competition for that off-peak wind power from various applications would drive up its price. The economics of CAES might not be harmed much by having to buy off-peak power at 3¢/kWh, but that would be a deal-breaker for Windfuels, unless gasoline prices were much higher than today's.

Then there's the question of how to value that hydrogen, once you've made it. Even with plenty of 1¢ wind power to generate the H2, its value is what it could be sold for. The vast majority of hydrogen today is produced from natural gas, and it can be worth as much as $10/kg at a commercial hydrogen station. That's the energy equivalent of 30¢/kWh. If electrolysis of off-peak wind power is such a good source of hydrogen, why not just stop there and sell the hydrogen into its large existing commercial and industrial market, without having to build the rest of the conversion hardware for making hydrocarbons?

Perhaps my receptiveness to the Windfuels concept was affected by the inventor's arguments slamming practically all other energy alternatives besides his, including biofuels (conventional, cellulosic and algae-based), hydrogen, solar power (ground-based PV, solar thermal and space solar power), nuclear (fission and fusion), unconventional hydrocarbons and electric vehicles as impractical or uneconomic. I suppose that might be an effective way to drum up financing in some quarters. Yet while I've expressed skepticism or reservations about certain of these approaches myself, it seems absurd to set up an untried process as the only viable alternative to our current energy sources, particularly for transportation energy. The good news is that Doty Energy has the same opportunity to prove its concept in the marketplace of ideas and financing as the thousands of others that have emerged in the last few years. Making it through all those gates and hurdles will be the only test of the viability of Windfuels that really matters.

Friday, February 04, 2011

It's hard to watch the current turmoil in Egypt and not wonder what it means for us, particularly with regard to energy. Although Egypt's oil production roughly balances its consumption, the Suez Canal and the Sumed pipeline, with its Mediterranean terminus west of Alexandria, represent important transit routes for Eastern Hemisphere oil going to Europe--though not as important as in the past. And while some politicians have already cited this situation as a "wake-up call" and indication of our energy insecurity, the risk of a serious supply disruption appears low, unless the protests spread to the major oil producing countries of the Middle East. Yet even short of that extreme, renewable energy stands to benefit from the uncertainty these events create, as reflected in higher crude oil prices.

I don't claim any unique perspective on the events in Egypt or their likely outcome, although some of the scenarios I can envision are extremely worrying. I've read heaps of articles and op-eds on the subject and listened to a media conference call from the Council on Foreign Relations, but if there's a consensus view I haven't found it yet. What I do see, however, is that since the protests started on January 25, and without any actual disruption in oil deliveries, the price of UK Brent crude--currently a better indicator of global oil prices than West Texas Intermediate--has climbed by around $5 per barrel and now trades solidly above $100. And while that might reflect other factors in addition to an Egypt risk premium, currency exchange rates don't seem to be one of them.

If the present instability persists or spreads, oil prices are likely to go even higher. Renewables such as ethanol and other biofuels could benefit from that in a way that they haven't from the general increase in oil prices since the middle of last year. That trend was mainly attributable to resurgent global economic growth, particularly from developing Asia. China's GDP grew by more than 10% last year. Along the way, the prices of renewable energy products that compete directly with oil went up, but so did the cost of inputs such as grains and oilseeds, as part of a general surge in global commodity prices. As a result the "crush spread", the margin for turning corn into ethanol, has contracted since mid-2010 and currently stands at essentially zero on the basis of prompt ethanol and corn futures. Biodiesel margins should have experienced something similar, if soybean oil prices are any indication. These products stand to gain if oil prices are driven up by factors that don't also push up the prices of the commodities from which they're made.

Of course that's not the only possible outcome. This week's Economist even notes the potential for a scenario yielding the opposite result. They see other Middle Eastern countries stockpiling grain to avert protests of the kind that have spread from Tunisia to Algeria, Egypt, Jordan and Yemen, and driving up its cost in the process. However, that element of the scenario is more credible than the accompanying suggestion that the region's oil producers might boost production to pay for that extra grain, thereby sinking oil prices. At current levels, the region's oil exporters are already earning on the order of $1.5 billion a day, and even a small producer like Oman should be taking in around $20 billion a year. Even at $9 per bushel the entire 2009/10 wheat imports of Lebanon, Iraq, Iran, Israel, Jordan, Kuwait, Saudi Arabia, the UAE and Yemen barely top $6 billion.

It's worth recalling that if the recent rise in oil prices is reminiscent of 2007 and 2008, OPEC has far more spare capacity in reserve this time. It has done a remarkable job of avoiding the temptation to pump more to gain market share. Even with some cheating around the quotas, they've kept the market tight. If OPEC changes that policy, it seems likelier they'd do so to avoid stalling the global recovery than to cover some additional grain imports for which they already have ample cash on hand. Stay tuned.

Wednesday, February 02, 2011

The edition of USA Today delivered to my hotel room yesterday morning included an interesting point/counterpoint concerning legislation that has been introduced to repeal the federal ban on incandescent lighting and the accompanying mandate for energy-saving light bulbs. Both sides included reasonable arguments but missed some key points. It's also important to recall that Congress did not specifically require the use of the compact fluorescent lights (CFL) that have become a focus of controversy, although it did set lighting efficiency standards that CFLs were best positioned to meet at an acceptable cost. Lost in the process is the larger question of whether the impact of more efficient light bulbs is really worth the associated risks and effort, including the economic and employment dislocation of offshoring a large portion of US light bulb manufacturing.

The lighting standard in question was just one provision of the 310 page Energy Independence and Security Act of 2007 (EISA), which also gave us the national Renewable Fuel Standard and more aggressive vehicle fuel economy rules. The case that the editors of USA Today made in defense of the bill's lighting efficiency provisions, which would be repealed by HR.91, the Better Use of Light Bulbs Act, was that it was a small but important step in the direction of saving energy and reducing emissions. They also lauded the bill for eschewing "picking winners" and instead focusing on the outcome of increasing the energy efficiency of lighting by whatever means could achieve that. I'm very sympathetic to that argument, though in this case the deck seems to have been stacked in favor of CFLs, in the absence of another widely-available and low-cost alternative bulb technology compatible with standard screw-in household lights. I'd also question their characterization of the payoff as "huge". I've looked at this before and concluded that the total energy savings involved in the switch amounted to just 2% of our annual electricity consumption--more than offset by higher usage from new devices. Emissions savings looked even smaller, at around 1%. The NRDC analysis cited in the editorial came up with emissions savings of 2%. Either way, more efficient lighting won't turn the US green.

With regard to the CFLs available today we are starting to see evidence that their performance has not measured up to claims, particularly concerning endurance. I have already had to replace a couple of supposedly long-life CFLs in applications involving frequent switching, wiping out any savings that might justify their higher cost. Of much greater concern is the health risk posed by the small quantity of mercury in each bulb. If you've read the EPA's instructions for remediating a room contaminated by a broken CFL bulb, you'd certainly think twice about putting one in any fixture that a child, elderly person or pet might knock over.

In his response to the editors, Representative Barton (R-TX), the author of HR.91, highlighted this risk and emphasized the intrusion of government into what ought to be a normal consumer decision concerning what kind of light bulb to buy. He also cited the transfer of much of the US lighting industry offshore, which is related to the technology of CFL bulbs. The phosphors they use require rare earth elements, for which China is the dominant global supplier. Unsurprisingly, China has gained a leading share of the global CFL industry, and US factories producing incandescent bulbs have closed, leading to higher imports of light bulbs from China and elsewhere.

Time to change course is running short. As of next January 1, the first tranche of the EISA efficiency standard will ban 100-Watt incandescent bulbs, mandating replacements that use at least 28% less energy to produce the same light output. The rules hit standard 75 W bulbs a year later, and 60 W bulbs on 1/1/14.

In my view the problem is less the federal lighting efficiency standard than the fact that CFLs are a poor technology. If it were oil companies, rather than the government, effectively forcing us to put these things in our homes, we would see protests in the streets against the health risks--and by many of the same environmental groups that now back CFLs but are trying to shut down coal-fired power plants that create less mercury exposure than a single broken CFL bulb in your house would. Instead of throwing out the entire lighting standard, we should focus on the most objectionable parts of these rules. Better lighting is on the way, with halogen bulbs now available for more applications, and much more efficient light-emitting diodes (LEDs) likely to become much cheaper in the future. We should stretch out the deadlines for phasing out incandescents to allow time for that to happen. I'd also like to see a "mercury deposit" charge applied to each CFL to ensure the bulbs are properly recycled at the end of their lives, along with a cigarette-style health warning on the packaging, warning consumers of the hazards. The modest energy and emissions savings CFLs produce simply don't justify overriding consumer choice and prudent judgment about where to use them and where not to.